SB 61-OIL/GAS LEASE: DNR MODIFY NET PROFIT SHARE  3:36:51 PM CHAIR REVAK announced the consideration of SENATE BILL NO. 61 "An Act authorizing the commissioner of natural resources to modify a net profit share lease." He asked Mr. Meza and Mr. Fitzpatrick to provide a recap of SB 61 and an overview of their response to questions the committee asked during the first hearing. 3:37:47 PM JHONNY MEZA, Commercial Manager, Division of Oil and Gas, Department of Natural Resources, Anchorage, Alaska, stated the information the department provided related to the three cases for which the department granted royalty modification. He explained there were eight applications for royalty modification: two where denied, three were withdrawn by the applicants, and the department approved the remaining three applications. For the approved applications, the department issued recent findings, received public comments, and gave a presentation to the Legislative Budget and Audit Committee (LB&A). MR. MEZA noted the department included additional information in their email response letter to the committee regarding the production that came from the royalty modification as well as revenues to the state as resource owner, specifically royalty and net profit share where applicable. CHAIR REVAK asked Mr. Fitzpatrick if he had anything to add. 3:40:02 PM RYAN FITZPATRICK, Commercial Analyst, Department of Natural Resources, Anchorage, Alaska, stated Mr. Meza covered the information that DNR provided to the committee. CHAIR REVAK asked why it would benefit the State of Alaska to modify royalty or net profit share leases. MR. FITZPATRICK replied the intent of the bill is to encourage development of resources would otherwise be stranded. He noted Chair Revak mentioned royalties and explained that current Alaska statute allows the DNR commissioner to modify royalty rates under three different scenarios: 1) to encourage new production from a field or pool that has not previously been produced, 2) to extend the life of existing production in the event that per barrel costs are increasing, or 3) to restore ceased production in a pool or field that is shut-in. MR. FITZPATRICK explained that SB 61 primarily would do two things. First it would allow for a fourth condition for royalty modification, or for potential modification of net profit shares in the event that a field is producing but additional capital investments is required to increase marginal production. The scenarios would include additional drilling, drilling pads, and enhanced oil recovery. If those projects were not economic on a standalone basis but could be made economic through royalty or net profit share modification, it would encourage additional investment and production. He said the second objective of SB 61 is to allow the modification of net profit shares under the same regime as royalty modification as currently allowed in statutes. That would be one of the three bases that the department already discussed, or potentially the fourth additional basis that the bill would add. 3:43:30 PM CHAIR REVAK noted he mentioned enhanced recovery efforts and asked him to confirm that as an oilfield produces over time, oil recovery becomes harder and more expensive. MR. FITZPATRICK answered yes, an oilfield over its life generally sees a decline in production. It is a common feature seen in North Slope oil fields and oilfields throughout the world. Initial production is high, but reservoirs drop over time. There are methods that producers can use to either slow oil production decline or temporarily increase production by injecting water or gas, polymer flooding, and a whole host of arrays that can be used. CHAIR REVAK asked him to confirm that DNR's position is that current oilfield development will become uneconomical and that is the reason for the legislation. MR. FITZPATRICK answered yes. He explained over time, any oilfield can potentially become uneconomic as seen throughout the world where oilfields producing over long periods of time eventually decline and no longer provide adequate revenues to meet operating expenditures and other financial commitments. Hypothetically, as oilfield production declines the modification of royalty rates and net profit share rates could extend the life of the oilfield a couple of years with increased revenues rather than the oilfield shutting down. MR. FITZPATRICK summarized that the department believes the bill could help to increase production over time from certain fields that might otherwise be economically disadvantaged. 3:47:03 PM SENATOR STEVENS expressed interest in knowing how often the department approves or denies modified lease requests. He noted the statement that there were eight royalty modification requests. He asked how often requests occur and does the department approve or deny a lot more requests. MR. FITZPATRICK explained the figures that Mr. Meza shared pertain to when the statute was first enacted in 1995. DNR has had eight applications for royalty modifications from 1995 to present. These requests do not occur annually and involve a lot of review work. CHAIR REVAK noted that the three modified applications were substantially lucrative to the state. He asked him to walk through the internal processes when somebody applies for a lease modification. MR. FITZPATRICK explained that royalty modification is generally reviewed by the Commercial Section within the Division of Oil and Gas. The review process varies depending on whether the application is for larger or smaller oilfields, or larger or smaller operators, but it is always in depth. The last oilfield the department reviewed took approximately 10-11 months. MR. FITZPATRICK detailed when the department reviews the application, there is generally a back and forth with the applicant to get all the information. If it is not forthcoming, the department can deny modification due to lack of information. MR. FITZPATRICK said the department has statutory authority to require or request an applicant pay for consultant fees to aid the department in its application review. Those consultants would provide expertise that the department may not have in- house such as reservoir engineering, accountants, or financial industry members that might have expertise in financial review. 3:52:04 PM MR. FITZPATRICK explained that once the applicant information is received, the department does its own evaluation and economic modeling. The primary evaluation objective is to determine whether the application meets the statutory requirements for royalty modification that were mentioned earlier. Each of the three scenarios potentially has subparts that each application would have to meet. MR FITZPATRICK said one of the primary considerations is that when the legislature passed the statute in 1995 to allow for royalty modification, one of its features is a heightened burden of proof that an application must meet for royalty modification eligibility. That is clear and substantial evidence. MR. FITZPATRICK detailed once the applicant review is finished, the Commercial Section briefs the Division of Oil and Gas and the DNR commissioner to determine whether there is additional review work for the division to conclude the application process; at that point, DNR would prepare and publish a best interest finding that includes a public comment period, an offer to LB&A for a hearing on the royalty modification, the best interest finding draft, and comments from the DNR commissioner. After the public comment period closes, the department must consider all public and legislative comments to incorporate and publish in its final best interest finding. 3:54:40 PM CHAIR REVAK noted the application process includes oversight by the public and LB&A, and only three out of eight applications have been approved. He asked Messrs. Meza and Fitzpatrick why the department is now asking for a modification, noting oilfield throughput has drastically decreased over the past few decades. MR. MEZA replied he is correct in referencing that the declining production from the state's producing fields may create a possibility that some of those pools may become uneconomic. One of the main goals with the proposed bill is that modifying the royalty rates, or the net profit share rate for the net profit share leases, can prevent declining oilfield production from abandonment and perhaps ensure continuing production and revenue to the state. SB 61 provides the DNR commissioner with another lever to modify parameters to encourage continuous or additional incremental production versus shutting down wells due to economic disadvantages. CHAIR REVAK noted the committee has strictly heard from the department on SB 61. He asked the Alaska Oil and Gas Association (AOGA) to provide their input. 3:57:54 PM KARA MORIARTY, President and CEO, Alaska Oil and Gas Association, Anchorage, Alaska, testified in support of SB 61. She explained AOGA is the professional trade association that represents the majority of explorers, producers, refineries, and pipeline company in Alaska. She said 2020 was an unprecedented year for the oil and gas industry. Even with COVID-19, the industry also experienced a pre-pandemic price war, and then the whole world turned upside down about a year ago from COVID-19. For the first time since Prudhoe Bay production started, drilling on the North Slope virtually stopped. There were no drilling rigs in Prudhoe Bay for the first time in history and the sector lost thousands of jobs. She noted while oil prices are rising and production in Alaska has largely rebounded to where production was before COVID-19, there are still effects from 2020. While the proposed legislation is not a new concept to allow for potential [net profit share lease] (NPSL) modifications, the timing for the legislation might be right because the state needs to do whatever it can to make sure the state's oilfields are economic and its fiscal regime remains competitive. SB 61 provides an additional regulatory tool in the state's toolbox to incentivize and grow production. MS. MORIARTY said she thinks Mr. Fitzpatrick did a nice job discussing how modifying current royalty rates for oil and gas leases is not easy. Modification does not happen overnight. There is very much a rigorous standard of proof, the economics absolutely have to warrant a change, and modification has to be in the best interest of the state. Allowing NPSL to go through the same type of process could be a very necessary and effective tool for providing flexibility in managing different cost structures, market dynamics, and project economics. MS. MORIARTY stated AOGA sees SB 61 as an additional tool to use on a case-by-case basis. It provides the option for DNR to work with the industry on any particular development. She summarized AOGA wants to see as much production as possible because it is good for the state, economy, jobs, and all Alaskans. 4:02:18 PM CHAIR REVAK opened public testimony on SB 61; finding none, he closed public testimony. 4:02:43 PM CHAIR REVAK held SB 61 in committee.